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This Annuity Strategy Lets You Have Your Cake and Eat It Too


Annuities can provide guaranteed income for retirement. You may choose to receive income upfront, with an immediate annuity or put it off until a later date with a deferred annuity. You could also combine those options into a split annuity strategy. This approach can help you enjoy immediate and future income but it’s important to understand how it works. SmartAsset’s matching tool can connect you with financial advisors who serve your area and have expertise in annuities.

Annuity Basics, Explained

An annuity is an insurance contract. When you purchase an annuity you agree to pay a premium to the contract issuer. This may be a one-time payment or a series of payments. In return, the annuity company agrees to pay money back to you at a predetermined date. Annuities have an accumulation period and a draw period.

During the accumulation period, the money in the annuity can grow. Annuities can use different investment strategies with varying degrees of risk and rewards. Once the accumulation period ends, the draw period begins. This is when you start getting money back from the annuity.

When these payments begin can depend on whether you choose an immediate or deferred annuity. An immediate annuity allows you to begin receiving payments fairly quickly after purchasing the contract. For example, your payments may begin one year from the contract purchase date.

A deferred annuity has a much longer accumulation period in which interest is earned. For instance, you might purchase a deferred annuity at age 55 and receive the first payment from it at age 65.

What Is a Split Annuity and How Does It Work?

A split annuity or split-funded annuity is not a specific type of annuity product. Instead, it’s an annuity strategy that uses both immediate and deferred annuities to fund your retirement income goals. With this type of arrangement, you’d purchase an immediate annuity and a deferred annuity, paying the associated premiums for both.

This does two things for you:

  • Create a smaller stream of immediate income for retirement
  • Receive larger payouts over the long-term

The advantage of this strategy is that you get some income upfront while your deferred annuity continues to grow in value on a tax-deferred basis. Assuming you’re getting a decent rate of return, the deferred annuity could be worth significantly more than what you paid for it once the draw period begins.

One thing you have to decide is whether you want to choose a fixed, variable or indexed annuity. Choosing a fixed annuity can ensure that you’ll receive a guaranteed rate of return on your money. Variable annuities and indexed annuities could offer higher returns but they’re subject to market risk. So it’s important to consider your risk tolerance and goals when choosing which type of deferred annuity to buy.

Split Annuity Example

Understanding How a Split Annuity Works

A split annuity strategy isn’t that complicated. Say, for example, that you’re 55 years old with $500,000 in savings and you want to use that money for a split annuity. You could take $200,000 of that and use it to purchase an immediate annuity that has a 10-year draw period. Then you could take the other $300,000 and use it to purchase a deferred annuity with a 10-year accumulation period.

Over the next 10 years, you receive payments from the immediate annuity. Meanwhile, your deferred annuity continues to grow, earning annualized rate of return each year. By the time the draw period for the annuity begins at age 65, it’s doubled in value to $600,000.

You can now draw payments from the deferred annuity to supplement your retirement income. Because you had the income from the immediate annuity, you didn’t need to apply for Social Security retirement benefits early. In fact, you’re now planning to wait until age 70 to take Social Security in order to maximize your benefits since you have your deferred annuity income to rely on.

Pros and Cons of Split Annuities

A split-funded annuity strategy can offer advantages and disadvantages and it’s important to consider both to help decide if it’s right for you.

On the pro side, here are some of the best reasons to consider a split annuity:

  • You can get immediate income to fund retirement or other goals
  • The deferred annuity will grow tax-deferred
  • Unlike a 401(k) or IRA, there are no contribution limits for annuities
  • Fixed annuities can provide a guaranteed rate of return

In terms of the cons, here are some of the potential drawbacks of split annuities:

  • Splitting funds means each annuity is smaller
  • Deferred annuities have more room to grow than immediate annuities
  • Surrender charges may apply if you decide to cancel one or both annuities

It’s also important to keep some of the general aspects of annuities in mind, starting with fees. Aside from surrender charges you may have to pay for canceling your contract, there are other annuity fees you might pay. Depending on where you’re purchasing the annuity contracts, these could easily add up to a sizable expense.

You also have to consider the quality and reputation of the annuity company itself. An annuity can only be paid out if the company is financially healthy and stable. If your annuity company were to go bankrupt you might not get anything at all. For that reason, it’s important to check annuity ratings to make sure you’re working with a reputable company.

Who Is a Split Funded Annuity Right for?

A split annuity may work better for some investors than others. This type of annuity strategy could make sense for you if you:

  • Have sufficient savings to fund multiple annuities
  • Want or need immediate income for retirement
  • Also want to create a long-term guaranteed income stream

If you’re not planning to retire for several years and don’t necessarily need current income, you may be better off concentrating savings in a single deferred annuity instead. Or it may be that an annuity isn’t a good fit for you at all, depending on your overall financial situation. Talking to your financial advisor can help you decide if an annuity is right for you and if so, which type of annuity strategy could work best.

The Bottom Line

Understanding How a Split Annuity Works

A split annuity, which is actually a way of using annuities rather than a specific type of annuity, can kill two birds with one stone when generating income for retirement. It’s a strategy that uses both immediate and deferred annuities to fund your retirement income goals. Before putting this strategy to work, it’s important to consider how well it fits your financial needs and goals. Researching annuity companies is a good place to start when deciding which annuity contracts to purchase.

Retirement Planning Tips

  • Annuities can provide guaranteed income but it’s helpful to look at your entire retirement picture. For example, when will you take Social Security retirement benefits? How much do you think you’ll need to withdraw from your 401(k) or IRA each year in retirement? What’s the value of your taxable brokerage account if you have one? Asking these kinds of questions can give you a more complete sense of where you’re starting from and what you might need to save to have the retirement you’re dreaming of.
  • Consider talking to a financial advisor about annuities and whether this type of financial product could be right for you. If you don’t have a financial advisor yet, finding one doesn’t have to be difficult. SmartAsset’s financial advisor matching tool makes it easy to connect with professional advisors in your local. You just need to answer a few brief questions to get your personalized advisor recommendations online.

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